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Option Strategies : Short Straddle
Summary:
A Short Straddle is an aggressive trade where the trader expects no real movement in the market. If so all the option premium will be kept from both the short call and short put. |
For traders who are generally neutral about a stocks potential. The stock may rise or fall but is generally in a range bound pattern. The trade works because both the option premiums fall.
| Risk: |
Unlimited |
| Reward: |
Limited |
| The Trade: |
Both an at the money call and put are sold short. |
ABC Stock trading at £5.00
Sell 1 Sep £5.00 call and sell 1 Sep £5.00 put (see pay-off diagram below
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| When to use: |
For aggressive investors who don't expect much short-term volatility, the short straddle can be a risky, but profitable strategy. If you only expect a moderately sideways market consider selling strangles instead |
| Volatility expectation: |
Bearish, volatility increases wreck the position. |
| Profit: |
Limited to the premium received. |
| Loss: |
Unlimited for either an increase or decrease in the underlying. |
| Breakeven: |
Reached if the underlying rises or falls from sold strike by the same amount as the premium received from establishing the position. |
| Time decay: |
Helps, especially when the trade is initiated in periods of high volatility |
| Short Straddle trading ideas and tactics: |
- Nice trade to put on after a big move on the expectation that prices will quieten down
- Maybe look to buy Strangles with part of the premium received - This would be for protection
- Always ask yourself serious risk questions before you do this trade. Many people will say it is a dangerous trade but only if you don't know what you're doing
- Consider starting to cover (reduce position) when 75% of premium is collected or in the final month, remember short dated options will increase the most on sudden moves. If you sell the straddle for 200 points the start to take profits if it trades down to 50 points etc
- Some sellers of straddles and strangles often use a simple stop; liquidate the entire position if the initial premium received gains by 50%-100%. So if you sold the strategy for 100 points, stop yourself out if it moves to 150 points or 200 etc
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